Let's use a pizza shop as an example. If the owner spends capital money and makes the line more efficient so that they can make twice as many pizzas per hour at peak, then physical productivity has improved. If the dining room sits empty because the tax burden was shifted from the wealthy to the poor, then the restaurant's BLS productivity has decreased. BLS productivity and physical productivity are simply unrelated in a right-wing country like the U.S.

Jeff's point brings to mind Walter Reuther's 1955 testimony before the Joint Congressional Subcommittee Hearings on Automation and Technological Chang:

Every tool on every operation has a green light, a yellow light, and a red light; and when all the green lights are on, it means that all the tools at each work station are operating up to standard. When a yellow light comes on, on tool No. 38, it means that the tool is still performing, but the tool is becoming fatigued and that is a warning sign, so that the operator sitting there looking at these panels will know that he has to get a replacement tool for tool No. 38. He stands by at that position on the automated machine, and at the point the red light would kick on, on the board, he walks over — the machine automatically stops — he puts the new tool in the place of the tool that is worn out, and automatically the green light comes on and the machine goes on.

When I went through this plant the first time I was told by a top official of the Ford Motor Co.: 'Mr. Reuther, you are going to have trouble collecting union dues from all of these machines.'

And I said: 'You know that is not bothering me. What is bothering me is that you are going to have more trouble selling them automobiles.' That is the real significance. We have mastered the know-how of mass production, and what we need to do is to develop comparable distribution know-how so that we will have markets for the tremendous volume of production that automation now makes possible.

Saturday, February 25, 2017

the border adjustment likely would make the corporate income tax substantially more regressive ... One of the major arguments that proponents of the border adjustment tax make is that it would stop corporate tax avoidance. It is certainly true that the border adjustment would remove companies’ incentive to use certain existing loopholes in our current system, but it would create numerous new opportunities for tax avoidance through the shifting around of sales. For example, Microsoft could avoid the tax by selling its software to consumers in the United States directly from servers in Ireland or another tax haven. At this point there is no reason to believe that following a tumultuous transition to a border adjusted tax that our tax system would end up less prone to tax avoidance than our current system.

The list of people realizing that will create new opportunities to game transfer pricing is growing. Permit me to address a somewhat related transfer pricing issue with respect to the proposed Trump Trade Accounting idea:

Let’s take an example based on Ford selling its cars to Canadian customers and having them manufactured in Mexico. Suppose Ford Canada sold a car for $20,000 that cost Ford Mexico $16,000 to produce and cost Ford Canada $2000 to distribute. Ford worldwide made $2000 in profits off of that car. The balance of trade statistics currently would take Ford’s transfer pricing as given so let’s speculate on how this might work. Suppose Ford US paid Ford Mexico cost plus 5% or $16,800 but then charged Ford Canada $17,600 on the premise that the Canadian distributor deserved a 12% gross margin as its operating expenses were 10% of sales. Ford US would retain $800 per car in profits for effectively doing nothing. Of course Ford might argue that this represents the value of Ford’s intangibles. I can see the tax authorities of Canada and Mexico disagreeing on this allocation of income. My simple point, however, is that current balance of trade accounting relies on the intercompany pricing of multinationals which at times can be suspect.

The classic example would be if we offloaded 100 BMWs on a ship in New York and then 20 were immediately sent up to Canada to be sold there. The way we currently count exports and imports, we would count the 20 BMWs as exports to Canada and also as imports from Germany. These re-exports have zero impact on our aggregate trade balance, but they do exaggerate out exports to Canada and our imports from Germany.

I’m not sure why this is the “classic” example but I suspect there is a very different supply chain envisioned in this BMW example versus my example. I will admit that automobile multinationals would prefer not to have taxable income in the U.S. but they are also aware that the IRS and other tax authorities in places like Canada, Germany, Japan, and Mexico have extensive knowledge of the transfer pricing aspects for their sector. While Ford might want Ford Canada to pay only $16,800 as income tax rates in Canada are lower than they are in the U.S. currently, Ford has to let this $800 remain in the U.S. if that represents the value of the Ford intangible assets owned in the U.S. So the Trump proposal would have something other than a “zero impact” in my example. So what is Dean’s example about? Let’s assume that these BMWs are sold in Canada and the U.S for $30,000 (all figures U.S. dollars), cost Germany $21,000 to design and manufacture, and incur $4500 in local selling and marketing costs. Consolidated profits are therefore $4500 per car. Through negotiations with the IRS, the Canadian tax authorities, and the German tax authorities, the U.S. and Canadian distribution affiliates will receive a 20 percent gross margin – that is Germany receives $24,000 per car which leaves them with $3000 in profits and $1500 in profits for the local distribution affiliate. Now if a ship landed in New York with 100 BMWs where 20 of them would be re-rerouted to Canada, then Dean is likely right – BMW Canada will pay $24,000 per car. But would this have to be first invoiced to BMW U.S. as he assumes? Not necessarily as doing so could cause all sorts of confusion for our customs agents. But let’s grant Dean this narrow example under the current tax law. But what would likely happen under DBCFT? Karl Keller, George Korenko, and Lori Hellkamp note:

rather than eliminating transfer pricing, the border adjustments will likely shift its focus, incentivizing multinationals to minimize the cost of imports by U.S. affiliates (because such costs would no longer be deductible expenses) and maximize U.S. affiliates’ revenue from exports (because such income would escape U.S. taxation and possibly even result in tax rebates)

They and ITEP talk about multinationals altering their supply sides. In our BMW example, imagine if BMW US took over the selling and marketing efforts in Canada eliminating BMW Canada as the U.S. has become an effective tax haven. In this case, they would import the 20 BMWs for $24,000 per car and export them for $30,000. Now you might say this is not the current U.S. tax system which is true. But consider nations like Hong Kong, Ireland, and Switzerland that are tax havens. This kind of transfer pricing activity is widespread and the implications for balance of trade accounting is considerable.

Friday, February 24, 2017

anne at Economist's View has retrieved a FRED graph that perfectly illustrates the divergence, since the mid-1990s of net worth from GDP:

The empty spaces between the red line and the blue line that open up after around 1995 is what John Kenneth Galbraith called "the bezzle" -- summarized by John Kay as "that increment to wealth that occurs during the magic interval when a confidence trickster knows he has the money he has appropriated but the victim does not yet understand that he has lost it."

In Chapter 8 of The Great Crash, 1929, Galbraith wrote:

"In many ways the effect of the crash on embezzlement was more significant than on suicide. To the economist embezzlement is the most interesting of crimes. Alone among the various forms of larceny it has a time parameter. Weeks, months or years may elapse between the commission of the crime and its discovery. (This is a period, incidentally, when the embezzler has his gain and the man who has been embezzled, oddly enough, feels no loss. There is a net increase in psychic wealth.) At any given time there exists an inventory of undiscovered embezzlement in – or more precisely not in – the country’s business and banks. This inventory – it should perhaps be called the bezzle – amounts at any moment to many millions of dollars. It also varies in size with the business cycle. In good times people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed. Money is watched with a narrow, suspicious eye. The man who handles it is assumed to be dishonest until he proves himself otherwise. Audits are penetrating and meticulous. Commercial morality is enormously improved. The bezzle shrinks."

In the present case, the bezzle has resulted from an economic policy two step: tax cuts and Greenspan puts: cuts and puts.

Thursday, February 23, 2017

Twenty-three and a half trillion, actually. But what's a few hundred billion? Here today, gone tomorrow, as they say.

At the beginning of 2007, net worth of households and non-profit organizations exceeded its 1947-1996 historical average, relative to GDP, by some $16 trillion. It took 24 months to wipe out eighty percent, or $13 trillion, of that colossal but ephemeral slush fund. In mid-2016, net worth stood at a multiple of 4.83 times GDP, compared with the multiple of 4.72 on the eve of the Great Unworthing.

When I look at the ragged end of the chart I posted yesterday, it screams "Ponzi!" "Ponzi!" "Ponz..."

To make a long story short, let's think of wealth as capital. The value of capital is determined by the present value of an expected future income stream. The value of capital fluctuates with changing expectations but when the nominal value of capital diverges persistently and significantly from net revenues, something's got to give. Either economic growth is going to suddenly gush forth "like nobody has ever seen before" or net worth is going to have to come back down to earth.

Somewhere between 20 and 30 TRILLION dollars of net worth will evaporate within the span of perhaps two years.

When will that happen? Who knows? There is one notable regularity in the data, though -- the one that screams "Ponzi!"

I’m in the market for a new pair of running shoes and am considering the latest from both Adidas and Nike. I will use my next shopping trip to explain the transfer pricing aspects of a devastating critique of the Destination Based Cash Flow Tax (DBCFT) from Karl Keller, George Korenko, and Lori Hellkamp (KKH):

Like others who have addressed the DBCFT in general, and border adjustments in particular, we have to make certain assumptions about how the border adjustments would work because the details in the proposal are so scant. Indeed, the description of the DBCFT occupies less than two pages of the proposal, and only a few sentences describe the border adjustments ... Likewise, rather than eliminating transfer pricing, the border adjustments will likely shift its focus, incentivizing multinationals to minimize the cost of imports by U.S. affiliates (because such costs would no longer be deductible expenses) and maximize U.S. affiliates’ revenue from exports (because such income would escape U.S. taxation and possibly even result in tax rebates) ... Consider an example to illustrate this point: A U.S. distributor acquires a product from a foreign manufacturer (FM) for $100 and resells it to U.S. customers for $160. (For purposes of this and the next example, we disregard currency adjustments in the figures, as the principle remains the same and, as seen above, perfect and immediate currency adjustments offering universal relief are unlikely.) The U.S. distributor can’t deduct the $100 paid to FM, meaning the distributor has taxable income of $160, with tax of $32 (at the proposed 20 percent rate). Without the border adjustment (and assuming the same 20 percent rate), the distributor’s tax would be only $12. Inevitably the U.S. distributor will try to push at least some of the economic burden of this additional tax cost onto FM.

Both Adidas and Nike are selling my perfect pair of shoes for $160. Each pay $80 per pair (50% of sales) for the design as well as the cost of hiring a Chinese manufacturer. Each incurs $48 per pair (30% of sales) for local sales and marketing expenses. Profits are $32 per pair or 20% of sales, which is divided between the parent corporation and the local distributor depending on the transfer pricing policy. Adidas Germany has established a U.S. distributor – Adidas America – to incur the sales and marketing expenses and in the KKH example, receives a 37.5% gross margin which equates to a 7.5% operating margin or $12 in U.S. profits on my pair of shoes. At a 35% U.S. tax rate, U.S. profits taxes are $4.20. Since the German profits tax rate is only 30%, the CFO of Adidas once wondered why they don’t raise the intercompany price from $100 to $110 but his tax director told him that the IRS team is insisting on their 7.5% operating margin. If DBCFT is adopted, the incentives change as a lower transfer price would eliminate German profits but not change the U.S. tax bill. This was the point of my Trump Toaster Oven example. So yea – transfer pricing manipulation could still exist but now this becomes a German problem. I suspect the German authorities might object if the intercompany price was reduced to $80. But at least the U.S. gets its $22.40 in sales tax – right? That might be true under a retail sales tax arrangement but not necessarily under a VAT. KKH also note that Adidas might scheme DBCFT by asking me to buy my shoes via the internet:

If, instead, FM, which otherwise has no nexus with the U.S., sells directly to the U.S. consumer for $160, it bears no U.S. tax. Without the imposition of a standalone import tax, FM can increase its profit—and even undercut the retail price relative to what U.S. distributors must now charge, while still making a higher profit. In short order, virtually all sales of foreign goods into the U.S. would be made direct to the end consumer, cutting out the tax-costly U.S. middleman.

Nike might look at this scheme and lament that the otherwise conservative folks at Adidas had outdone them in terms of transfer pricing aggression. Nike is known for sourcing some of its foreign based profits in Bermuda but credit the IRS on currently insisting that Nike pay the U.S. some of the intangible profits. DBCFT, however, would give Nike a huge tax break on its foreign sourced income. But Nike also realizes that half of its approximately $30 billion in sales per year are to U.S. customers like me. KKH note that Nike could pull the same trick:

Taking this example one step further, a U.S. seller into the domestic market will also have a strong incentive to adopt this same strategy. Assume a U.S. manufacturer sells the same product as in the above example, with a cost of production of $80. It will sell to a U.S. customer at the market price of $160, and would be subject to tax of $16, resulting in an after-tax profit of $64 ($80 – $16). But if it established a foreign distributor (FD) and sold the product to FD for $150, followed by FD’s resale to the U.S. customer for $160, the U.S. seller would have $70 of profit, subject to no U.S. tax—plus the $10 of profit residing in FD, also subject to no U.S. tax (assuming FD otherwise has no U.S. taxing nexus; for that matter, FD need not be related—U.S. sellers would probably find little difficulty locating foreign companies willing to earn modest profits for acting as a go-between).

A more traditional VAT would also be expected to withstand a WTO challenge, be compatible with the U.S.’s existing network of income tax treaties, and enjoy the benefit of other countries’ experiences, which could provide guidance for a VAT’s adoption and implementation. This conclusion may seem obvious, but only if one ignores political realities—there is no appetite in Congress for enacting a ‘‘new tax,’’ particularly one that would ultimately fall on American consumers.

Indeed there are simpler ways of accomplishing what Alan Auerbach wants to do but Paul Ryan does not a clear and honest debate over tax policy. Paul Ryan is also making a lot of wonderful sounding claims about DBCFT but then when has Ryan ever been honest about tax policy? Oh well – time to go shopping.

Wednesday, February 22, 2017

For nearly a half a century, from 1947 to 1996, real GDP and real Net Worth of Households and Non-profit Organizations (in 2009 dollars) both increased at a compound annual rate of a bit over 3.5%. GDP growth, in fact, was just a smidgen faster -- 0.016% -- than growth of Net Household Worth.

From 1996 to 2015, GDP grew at a compound annual rate of 2.3% while Net Worth increased at the rate of 3.6%.

Responding to an editorial in the New York Times, Jared Bernstein reprised a theme that Dean Baker has been stressing for a while -- that productivity and investment measures don't support the "robots are stealing jobs" story. I agree with Jared and Dean that it is policy, not robots that are stealing the jobs. But I am skeptical about using productivity numbers as evidence against the role of labor-saving technology in displacing people from employment.

The reason for my skepticism is that labor productivity is a ratio between two very broad aggregates -- GDP and hours worked -- that lump together a myriad of disparate economic factors. Here is the argument I made to Dean back in December. He was not persuaded:

The difficulty I have with the evidence you [Dean] use for your argument has to do with the changing composition of the aggregate measures that make up the productivity calculation and the possibility that confounding variables in each of those aggregates may be "compounding the confounding" when used for year-to-year comparison.

As Block and Burns pointed out, the National Research Project that developed the original productivity estimates argued that "no such thing exists in reality" as the productivity of a group of diverse products. Instead they presented two calculations of productivity, using different weighting, to show that the "measurement" depended in part on the weighting of the variables.

The shift from physical output to GDP measures obscured the fact that there is "no such thing" as the productivity of a diverse collection of products. Monetary value converts those diverse products into so much "leets" -- to use Joan Robinson's sarcastic term. Obviously the mix of goods and services that make up the GDP differs from year to year. The GDP deflator is intended to adjust for price changes and quality improvements but doesn't deal with distributional changes and product substitution.

The government services component of national income has been a particular issue, the critique of which goes back to Kuznets's 1947 criticism of the Commerce Department's GNP and Kaldor's statistical appendix to Wm. Beveridge's Full Employment in a Free Society. Kuznets argued that much of government services should be treated as intermediate goods rather than final consumption goods. Kaldor considered the inflationary affects of government deficit spending, arguing that some of that "inflation" simply reflected the increased share of collective consumption. Warsh and Minard offered a critique of "inflation" in the 1970s that could easily have referenced Kuznets'sand Kaldor's arguments. Their idea was basically that as government expenditure increases as a percentage of GDP, much of the taxation to pay for it is passed on to the consumer in the form of higher prices. It is an argument about the incidence of taxation.

Finally, there is the question of the "productivity" of hours of work themselves. Presumably there is an optimal length (or innumerable optimal lengths) of the working day, workweek or year and variation above or below that optimum will result in lower output per hour. Aggregate hours of work and average annual or weekly hours do not reflect changes in the dispersion of hours of work that may in turn be affecting the productivity of hours. Computationally, this injects a circular reference into the measurement of productivity. If you tried to do this on an Excel spreadsheet you would get an error message. It is only by ignoring the feedback effect of changes in hours and changes in dispersal of hours that productivity can be calculated as GDP/Hours.

By definition, new technology introduces changes in product mix and changes in work arrangements. But also, by definition, the two components of the productivity calculation assume "no change" in product mix or work arrangements. So I'm having trouble seeing how a ratio that relies on an assumption of no change could be adequate to measure the effects of change.

When Jared posted his commentary, I wanted a quantitative illustration of the point I was trying to make. I had already been wondering about the question raised by Bill Gates about taxing robots and the idea that wealth creation might be "bypassing" income, so I looked up the net worth statistics.

After a bit of number crunching, I am astonished at what I see in the numbers. It is not just the discrepancy between GDP and net worth that impresses me but also the long period prior to 1996 during which the two numbers grew at a very similar rate. In the chart below, I have indexed both series to 100, with 1996 as the reference date. The smooth curve is actually two trend lines based on the 1947 to 1996 trend for each series:

Logically speaking, and using the plain language meaning of the terms, wealth is something that is produced. So increases in wealth presumably are predicated on increases in production. It makes intuitive sense that over the long run there would some sort of stable relationship between the growth rates of GDP and of wealth. I was not anticipating, however, such a close fit between the two series from 1947 to 1996. It only accentuates the disjuncture between GDP growth and growth of Net Worth after 1996.

The above chart only goes to the end of 2015, so it doesn't include the recent stock market boom. Nevertheless, it presents an unsettling picture.

Returning to the puzzle of productivity, the point that I was trying to illustrate is that the comparability of the productivity measure requires a good deal of faith in the proportional stability of the economic relationships over time. If there are significant shifts in employment by sector, technology, resource availability, trade arrangements and/or consumption tastes, then comparing productivity between periods is futile. There is too much noise in the component aggregates to begin with -- but using a ratio between them amplifies the noise.

Tuesday, February 21, 2017

U.S. President Donald Trump's administration is mulling changes to how it calculates U.S. trade deficits in a way that would likely help bolster political arguments to renegotiate key trade deals, the Wall Street Journal reported on Sunday, citing people involved in the discussions….If the government adopted the new method, the deficit with Mexico would be nearly twice as high. The Journal reported that career government employees at the U.S. Trade Representative's (USTR) office objected to a request to prepare data using the new methodology.

The Wall Street Journal story can be found here if you can get past the fire wall. Tyler Durden appears to be unhappy with this idea and reports:

According to WSJ sources, the White House is considering not counting re-exports from the US trade balance: i.e., excluding from U.S. exports any goods first imported into the country, such as cars, and then transferred to a third country like Canada or Mexico unchanged. Such an approach would inflate trade deficit numbers because it would typically count goods as imports when they come into the country but not count the same goods when they go back out.

That does seem odd. Let’s take an example based on Ford selling its cars to Canadian customers and having them manufactured in Mexico. Suppose Ford Canada sold a car for $20,000 that cost Ford Mexico $16,000 to produce and cost Ford Canada $2000 to distribute. Ford worldwide made $2000 in profits off of that car. The balance of trade statistics currently would take Ford’s transfer pricing as given so let’s speculate on how this might work. Suppose Ford US paid Ford Mexico cost plus 5% or $16,800 but then charged Ford Canada $17,600 on the premise that the Canadian distributor deserved a 12% gross margin as its operating expenses were 10% of sales. Ford US would retain $800 per car in profits for effectively doing nothing. Of course Ford might argue that this represents the value of Ford’s intangibles. I can see the tax authorities of Canada and Mexico disagreeing on this allocation of income. My simple point, however, is that current balance of trade accounting relies on the intercompany pricing of multinationals which at times can be suspect.

Monday, February 20, 2017

While the House Republicans are pushing that Destination Based Cash Flow Tax, President Trump has other ideas as do the Senate Republicans. Trump wants to encourage U.S. net exports by simply placing a 20% tariff on goods from Mexico while some in the Senate want to simply reduce our corporate profits tax rate to 20% (Mexico’s corporate profits tax rate is 30%). Suppose we do both – keep the corporate profits tax but at a lower rate and impose tariffs on imports from Mexico. Not that I’m endorsing either but this GAO document was interesting with its title:

Congress enacted section 1059A in 1986 to improve IRS' enforcement of transfer pricing regulations. Section 1059A was designed to prevent the federal government from being whipsawed by an importer, on property acquired from a related party, who claims a low valuation for customs purposes and a higher valuation for tax purposes ... The legislative history of the section indicates that the section was intended to address the Tax Court holding of Brittingham v. Commissioner. In this case, IRS determined that a U.S. importer paid more than an arm's length price for ceramic tile imported from a related party in Mexico. The purchase price exceeded the value reported for customs duty purposes.

This case dates back to intercompany pricing when John Kennedy happened to be President. Imagine you were a homeowner way back then and you purchased $100 in ceramic tile that cost the Mexican affiliate of a multinational $60 to produce and $20 for the U.S. affiliate to distribute. The $20 in profits would have been taxable partly in Mexico and partly in the U.S. depending on the transfer pricing policy, which we was set at $66 for Mexican income tax purposes and U.S. customs purposes. But somehow this multinational got away with telling the IRS that the intercompany price was $80 for U.S. income tax purposes. So it got away with a low customs duty charge and having about 70% of its profits tax-free for income tax purposes. Nice trick I guess. So yea – section 1059A was sort of a good idea. But here is where this gets weird:

According to IRS officials, since 1986 IRS has raised section 1059A issues in nine audits. Furthermore, when raised in audits, its application has been primarily directed at taxpayers operating under the maquiladora program--U.S.-owned manufacturing and assembly operations in Mexico (maquiladoras) that export their products back to the United States. About 2,100 maquiladoras exported products to the United States in 1991 ... In response to our inquiry on legislative options, IRS' Office of Chief Counsel concluded in a January 7, 1993, letter that the issue addressed in the technical advice memorandum is not a tax problem. Rather, it believed that the problem is with customs valuation that results from a loophole in customs legislation. The letter concluded the issue should be resolved by amending customs law.

So the remedy is to ask any multinational declaring inconsistent transfer pricing to pay more customs duties? And the focus was on Mexican maquiladoras? I bet you caught the irony of the fact that this document was issued in 1994 just as NAFTA kicked in eliminating most tariffs on imports from Mexico. One should also remember that even before NAFTA that the entire point of the maquiladora program was to allow U.S. multinationals to import goods manufactured in Mexico duty free.

Sunday, February 19, 2017

In an earlier post, Peter Doman, "would sincerely appreciate intelligent arguments from the degrowth side" in response to the question of "whether declining investment is an occasion for celebration?" In Dorman's opinion, "degrowth is a suicide cult masquerading as a political position."

In a nutshell, the degrowth argument is that there are real limits to growth and that consequently an end to growth will happen whether it is desired or not, planned or unplanned. It would thus be prudent to mitigate the prospective end of growth by planning for it, to whatever extent possible.

Degrowth, is thus not a utopia but a cautionary tale. Here is how Georgescu-Roegen framed the matter in his 1975 article, "Energy and Economic Myths":

Undoubtedly, the current growth must cease, nay, be reversed. But anyone who believes that he can draw a blueprint for the ecological salvation of the human species does not understand the nature of evolution, or even of history -- which is that of permanent struggle in continuously novel forms, not that of a predictable, controllable physico-chemical process, such as boiling an egg or launching a rocket to the moon.

In conclusion, he conceded that "The most we can reasonably hope is that we may educate ourselves to refrain from 'unnecessary' harm..." and dismissed notions of "complete protection and absolute reduction of pollution" as "dangerous myths." Acknowledging the impracticality of a "complete renunciation of... industrial comfort," Georgescu-Roegen instead sketched what he termed a "minimal bioeconomic program":

First, the production of all instruments of war, not only of war itself, should be prohibited completely. It is utterly absurd (and also hypocritical) to continue growing tobacco if, avowedly, no one intends to smoke. The nations which are so developed as to be the main producers of armaments should be able to reach a consensus over this prohibition without any difficulty if, as they claim, they also possess the wisdom to lead mankind. Discontinuing the production of all instruments of war will not only do away at least with the mass killings by ingenious weapons but will also release some tremendous productive forces for international aid without lowering the standard of living in the corresponding countries.

Second, through the use of these productive forces as well as by additional well-planned and sincerely intended measures, the underdeveloped nations must be aided to arrive as quickly as possible at a good (not luxurious) life. Both ends of the spectrum must effectively participate in the efforts required by this transformation and accept the necessity of a radical change in their polarized outlooks on life.

Third, mankind should gradually lower its population to a level that could be adequately fed only by organic agriculture. Naturally, the nations now experiencing a very high demographic growth will have to strive hard for the most rapid possible results in that direction.

Fourth, until either the direct use of solar energy becomes a general convenience or controlled fusion is achieved, all waste of energy -- by overheating, overcooling, overspeeding, overlighting, etc. -- should be carefully avoided, and if necessary, strictly regulated.

Fifth, we must cure ourselves of the morbid craving for extravagant gadgetry, splendidly illustrated by such a contradictory item as the golf cart, and for such mammoth splendors as two-garage cars. Once we do so, manufacturers will have to stop manufacturing such "commodities."

Sixth, we must also get rid of fashion, of "that disease of the human mind," as Abbot Fernando Galliani characterized it in his celebrated Della Moneta (1750). It is indeed a disease of the mind to throw away a coat or a piece of furniture while it can still perform its specific service. To get a "new" car every year and to refashion the house every other is a bioeconomic crime. Other writers have already proposed that goods be manufactured in such a way as to be more durable. But it is even more important that consumers should reeducate themselves to despise fashion. Manufacturers will then have to focus on durability.

Seventh, and closely related to the preceding point, is the necessity that durable goods be made still more durable by being designed so as to be repairable. (To put it in a plastic analogy, in many cases nowadays, we have to throw away a pair of shoes merely because one lace has broken.)

Eighth, in a compelling harmony with all the above thoughts we should cure ourselves of what I have been calling "the circumdrome of the shaving machine," which is to shave oneself faster so as to have more time to work on a machine that shaves faster so as to have more time to work on a machine that shaves still faster, and so on ad infinitum. This change will call for a great deal of recanting on the part of all those professions which have lured man into this empty infinite regress. We must come to realize that an important prerequisite for a good life is a substantial amount of leisure spent in an intelligent manner.

"Right now, the human worker who does, say, $50,000 worth of work in a factory, that income is taxed and you get income tax, social security tax, all those things. If a robot comes in to do the same thing, you’d think that we’d tax the robot at a similar level." -- Bill Gates

Gates is suggesting taxing robots as a way of financing the retraining of displaced workers -- not as a measure to inhibit their introduction. But, of course, taxes act as disincentives for the taxed activity as well as revenue generators.

Tim Worstall thinks taxing robots is a bad idea "because we don't want to tax production at all." What does Worstall propose instead of taxing robots? "Exactly the same places we get the tax revenue from today, from some combination of everyone's incomes and or consumption." Worstall believes that since the introduction of robots will increase aggregate production, that will automatically increase tax revenues to offset the lose of tax revenues from the incomes of workers displaced by robots.

Unfortunately for Worstall's argument, he fails to distinguish between physical production and value production and as a consequence overlooks the question of distribution of the latter. There may be a larger quantity of goods and services produced, having a greater aggregate value but a larger proportion of that value may consequently be sheltered from taxes. In fact, it probably is because of tax policies that seek to encourage investment (not to mention tax havens and other loopholes).

In short, taxation is not some exogenous distortion imposed on a fine-tuned, market-based economic machine. It is part of the underlying structure. Whether or not "taxing robots" makes sense, Gates's comments address a real conundrum. Changing the income shares of capital and labor has an impact on tax revenues that is not automatically compensated by aggregate growth of GDP.

Hey, degrowthers! I know you’re out there. I’d like to get your take on a post by Tim Taylor on investment. Taylor points out that both gross and net investment as a share of GDP have been falling in the US, net faster than gross. (Deduct investment that replaces depreciation from the gross figure and you have nothing but net.) Here is his key diagram, culled from FRED.

There is a lot of cyclical variability, but peak to peak or trough to trough we’re definitely headed down.

So my question for the degrowth community is whether declining investment is an occasion for celebration? Does this mean that economic policy is actually getting something right?

Here’s one answer I won’t accept: we don’t care about growth in general, just growth of bad stuff, like fossil fuels, accumulation of waste, destruction of coastlines, etc. That isn’t a degrowth position. Everyone wants more of the good and less of the bad, however they define it. I’m in favor of only toothsome pizza crusts and I’m dead set against the soggy kind, but that’s not the same as being on a diet.

This is a practical, policy-relevant question. There are many smart economists trying to understand the investment slump so they can devise policies to turn it around. You’ll notice this concern is prominent in the writing on increasing industrial concentration, the shareholder value obsession, globalization and outsourcing, and other topics. The goal of these researchers is to reform corporate and market structure in order to restore a higher rate of investment, among other things. That of course would tend to accelerate economic growth. So what’s the degrowth position on all this? Should economists be looking for additional measures to discourage investment?

Again, please don’t tell me that it’s just investment in “bads” that needs to be discouraged. That’s a given across the entire spectrum of economic rationality (which is admittedly somewhat narrower than the political spectrum). In the aggregate, is it good that investment is trending down?

My own view, as readers of this blog will know (see here and here), is that degrowth is a suicide cult masquerading as a political position. I’m pretty sure that radically transforming our economy to make it sustainable will involve a tremendous amount of investment and new production, and it seems clear to me that boosting living standards through more and better consumption is both politically and ethically essential. But I could be wrong. I would sincerely appreciate intelligent arguments from the degrowth side.

Saturday, February 18, 2017

In the course I’m currently teaching one of the required books is Gender, Work, and the Economy by Heidi Gottfried. Reading the introduction to the second chapter I came across this gem:

To begin, the chapter elaborates on the basic tenets of feminism, arguing that women suffer discrimination due to their subordinate positions in gender systems of inequality (Delmar, 1986: 8).

Note that this profound observation comes to us with the pedigree of a citation! In case you were wondering what systemic discrimination could possibly have to do with systems of inequality, you now have an authority to summon.

No doubt the quote rests on a fine distinction between widespread inequalities suffered by individuals belonging to a common group and the inequality of that group, and readers for whom this is important can fill me in on it. They are the ideal audience for this book.

Friday, February 17, 2017

From "The Flaneur, the Sandwichman and the Whore: the politics of loitering," Susan Buck-Morss:

The flaneur is the prototype of a new form of salaried employee who produces news / literature / advertisements for the purpose of information / entertainment / persuasion (the forms of both product and purpose are not clearly distinguished). These products fill the "empty" hours which time-off from work has become in the modern city. Writers, now dependent on the market, scan the street scene for material, keeping themselves in the public eye and wearing their own identity like a sandwich board.
A salaried flaneur profits by following the ideological fashion. Benjamin connects him ultimately to the police informer and in a late note makes the association: "Flaneur - sandwichman - journalist-in-uniform.The latter advertises the state, no longer the commodity." In an economically precarious and ideologically extremist climate like the 1930s the penalty for a writer's refusal to toe the political line could be great.

The topic of fake news is dear to the Sandwichman to the extent I take my nom de plume from Benjamin's commentary in his notes for the Passagenwerk. The intellectual employee may deny what he or she objectively is -- a salaried thinker -- but cannot escape being one, except by virtue of unemployment.

The spectacle we are currently being entertained by is essentially a turf battle between competing factions of journalist-in-uniform police informers. Are there grounds for critically supporting one faction in its opposition to the other? Yes, there are. The so-called President's objection to fake news is specifically that it is not fake enough -- it does not toe his political line. In an economically precarious and ideologically extremist climate the penalty for not distinguishing between ideologically-distorted news and politically-dictated news could be great.

OK, so the immediate reaction of many to this title might be to laugh, but I challenge anybody reading this to name another Fed Chair who was clearly better than she is. I do not think you can. However, one reason why one may not think much about her is that things have been so inconsequential since she has been Chair. Nothing much has happened. She continued the Quantitative Easing for awhile started by Bernanke and then stopped it. Inflation has remained below 2% mostly. Growth has not been dramatic, but it has been steady and higher than in most other advanced market capitalist economies. There has not been a recession since 2009. There have been no bubbles and no crashes. Nothing dramatic has happened and certainly nothing bad, even if lots of deep problems of the US economy such as inequality remain. But that one is not the Fed's responsibility anyway. So, bottom line, she has been doing a great job even if everybody is quite certain Trump will replace her, with all kinds of candidate names being thrown around. But none of these will be better than she has been.

So, going backwards her most serious rival might be her immediate predecessor, who looks to have played a substantial role in the save of September, 2008 that involved buying a lot of eurojunk from the ECB, only to roll it off over the next six months or so. Of course some of the more innovative things done then were coming out of the NY Fed, but Bernanke did an excellent job when the crisis hit. At the same time, Janet was around during that period, initially as San Fran Fed president, and then later as Vice Chair. But where Bernanke looks not so good is the runup to that crisis, where he seems really not to have seen it coming. Who saw it coming and as far back as 2005 sounding the alarm about the housing bubble? Oh, right. Janet Yellen.

Frankly the records look worse as one goes back further in time. Of course Alan Greenspan got lots of praise during the "Great Moderation," but then many later decided that he laid the groundwork for the housing bubble and crash that came later, and even he himself has admitted that he may have contributed to it. I give him credit for a great save at the time of the 1987 crash, but it does seem that he stayed in too long and deserves some of the blame for what came later.

Volcker gets lots of praise for breaking the inflation that came out of the 1970s, but then this was done in connection with the deepest recession since the Great Depression, even if it did not last long. His legacy is certainly a mixed bag. G. William Miller before him was viewed as pretty much of a disaster with inflation taking off under him, and with his predecessor, Arthur Burns getting blamed for stagflation, even if it was not all his fault. Earlier Fed chairs in the 40s, 50s, and 60s had a generally strong economy to deal with, but they had this tendency to "take away the pumchbowl just as the party got going," leading to stop and go policies that marked that period.

Arguably earlier chairs had greater challenges with the Great Depression and World War II, but in much of that either they engaged in disastrous policies or were subordinate to others, and behavior of the Fed chairs early in its history seems to have bee mostly awful, with the recession of the early 20s and then the reatlly total botches of 1929 and 1931, with Bernanke struggling to avoid the mistakes made in that latter year, which turned what had been a bad recession into the Great Depression.

So, really, Janet Yellen looks about as good as they get when you think about it. We are now in a situation where Donald Trump has three openings on the Board of Governors to appoint. I have no idea who he will pick, but I lay odds that they will not improve what goes on there, especially if he decides to go for some gold bug nuts or whomever. However, for all the talk now that assumes it is a done deal that she will be replaced, if things go downhill for Trump, it may come to pass that he may be betting Yellen to stay on next January, although I shall not bet on that. In the meantime, she and Obama and others have handed him a pretty well functioning economy that will probably continue to do well at least for awhile to come and that he will take credit for. We shall see.

Thursday, February 16, 2017

“Tomorrow, they will say, ‘Donald Trump rants and raves at the press.’ I’m not ranting and raving. I’m just telling you. You know, you’re dishonest people. But — but I’m not ranting and raving. I love this. I’m having a good time doing it.

"But tomorrow, the headlines are going to be, ‘Donald Trump rants and raves.’ I’m not ranting and raving.”

It’s common to use W (wage) on the price axis and N (number of workers) on the quantity axis. Equilibrium is supposed to occur at the W where quantity supplied equals quantity demanded. From here you might introduce statutory minimum wage laws, or jobs with different nonpecuniary benefits and costs, etc. The default conclusion is that free markets are best.

But hold on a moment. S and D don’t tell you how many workers actually have jobs or how many jobs are actually filled—these are offer curves. The S curve tells you how many workers would be willing to accept a job at various wages, and the D curve tells you how many jobs would be made available to them. That’s not the same as employment.

They would be the same in a world in which labor markets operated according to a two-sided instantaneous matching algorithm, something designed by Google with no human interference at any stage of the process. In such a world all offers would enter a digital hopper, and all deemed acceptable by someone else’s algorithm would be accepted immediately. Maybe not Google but Priceline.

But that’s not the world we live in. Finding out about job openings and job applicants is somewhat haphazard and time-consuming. Applicants and jobs differ from one another in lots of obscure, subtle but crucial ways. You really wouldn’t want an algorithm to make these decisions. And so only some workers who offer their labor, even at what might be an equilibrium wage rate, are taken on, and only some job openings workers willingly apply for are filled. When we measure unemployment and vacancies à la JOLTS, we are not seeing offers but changes in actual employment and disemployment.

So let’s redraw that diagram.

To the left of N*, the equilibrium number of employment offers, we find N**, the number of workers whose offers have actually been accepted and are now on the job. A little reflection should be enough to indicate that S&D is a lousy way to frame this distinction.

First of all, what determines this gap between wanting to work (or fill a job) and actually working (or filling it)? What does this apparatus tell you about N*–N**? Nothing. It isn’t built to answer that question, and it doesn’t answer it.

But it’s worse. The apparatus indicates that N*–N** is the same on both sides of the market: the number of workers looking for work is exactly equal to the number of jobs looking for workers. But why would we expect that to happen? What reason is there to think that it’s equally easy for workers to find jobs and jobs to find workers? On the contrary, the ratio of unemployed workers to job openings never falls to 1.0, or hasn’t since we’ve had JOLTS to inform us.

S&D is simply the wrong model, based on a failure to distinguish between offers and transactions. Fortunately, there’s a better model out there, search theory, with fairly straightforward intuitions and tons of available data.

Anyone who waves an S&D model at me and makes claims about the labor market is simply advertising that they know less about economics than they think they do.

Wednesday, February 15, 2017

Small aside on the border adjustment: a border adjustment eliminates the incentive to game the system by shifting profits offshore, but it does so by exempting profits on exports from any onshore tax. It basically abandons the notion of trying to tax the intellectual property (IP) rents on export income, or the economic rents from the export of natural resources for that matter. And it could create incentives for other kinds of gaming. I am convinced that the current system is heavily gamed in ways that hurt U.S. exports of IP and high-margin products (the active ingredient in pharmaceuticals for example), but the proposed border-adjustment gets rid of some of the games by in effect not taxing certain kinds of hard-to-tax income.

I have seen some rough guesses of the alleged net revenue gains from DBCFT based on the simple minded notion that our imports exceed our exports. But if Greg Mankiw is right about this being eliminating the corporate profits tax in favor of VAT, then these rough guesses may be all wrong. I will try to explain using four examples two of which we shall discuss today. A 1989 discussion from the GAO explained how both a tax-credit VAT and a subtraction VAT works:

Both the subtraction and tax-credit methods of calculating a value added tax are based on the premise that value added is equal to a firm’s sales minus purchases. The methods differ in what information is used to calculate the tax. The subtraction method calculates the tax once during the reporting period on the total business activity of the firm. It is simply the total value of sales minus the total value of purchases multiplied by the tax rate. In contrast, the tax-credit method is calculated on the basis of individual transactions, i.e. on each sale and purchase. The individual calculations are then aggregated into the total taxes on sales and the total taxes on purchases. The difference is the tax liability of the firm.

We will deal with subtraction VAT later this week but our current examples are based on imports from Europe which relies on tax credit methods. Rick Steves provides the relevant tax rates for European nations. Let’s imagine you bought a $10 bottle of French wine on the way home to celebrate Valentine’s Day with your wife. The multinational that sold you this bottle spent $7 in France making the wine and $2 in the U.S. on distribution costs. The intercompany price between the French parent and the U.S. affiliate was set a $7.50 by a bilateral Advance Pricing Agreement (APA) where the multinational did care want to game anything as French income tax rates are almost as high as the current U.S. profits tax rate. The French parent ended up paying $0.10 on French VAT since its value-added of $0.50 was taxes at a 20% rate. Auerbach would have us have the same VAT but then abandon the profits tax. So at this transfer price we would also get $0.10 in VAT after the tax credit and the labor subsidy are factored in but lose out on the $0.175 in income taxes. Auerbach et al. admit:

Taxing business income in the place of destination also has the considerable advantage that the DBCFT is also robust against avoidance through inter-company transactions. Common means of tax avoidance – including the use of intercompany debt, locating intangible property in low-tax jurisdictions and mispricing inter-company transactions - would not be successful in reducing tax liabilities under a DBCFT. Here however the distinction between universal and unilateral adoption is important. With adoption by only a subset of countries, those not adopting are likely to find their profit shifting problems to be intensified: companies operating in high tax countries, for instance, which may seek to artificially over-price their imports, will face no countervailing tax when sourcing them by exporting from related companies in DBCFT countries.

As Brad notes – gaming the system will continue as our multinational will be tempted to lower the transfer price to $7 a bottle wiping out French profits. This change if allowed would increase U.S. VAT by lowering French VAT. Of course the French tax authorities would strongly object. Auerbach might advise the French to follow our lead by eliminating their corporate profits tax and relying exclusively using VAT. I don’t exactly see that happening but let’s talk about your lovely wife who was the real big spender buying you a $100 Swiss watch, which cost the Swiss parent $70 to make and its U.S. affiliate $20 to distribute. The current transfer price is set at $75, which makes this example a lot like that cheap bottle of wine you bought her. Since Switzerland has both low income taxes and a low VAT, I leave it to your brilliant wife to explain to you the details.

Monday, February 13, 2017

When Ullman won his first race for the House in 1960, he was regarded as a solid liberal -- which only made his victory more surprising, because his district was historically conservative. Once in Congress, Ullman solidified his left-leaning credentials, earning a 100 percent rating from Americans for Democratic Action (ADA) in 1961.

By 1974, his ADA rating fell to just over 50%. What changed?

Ullman's education at Ways and Means apparently included a course on consumption taxes, because he came to believe deeply in their relative efficiency. He put ideas into action by introducing the Tax Restructuring Act of 1979. The bill, introduced in late October, featured $130 billion in cuts to existing taxes, offset by $130 billion in new revenue from a federal VAT. The sluggish economy of the late 1970s needed a shot in the arm, and tax cuts were just what the doctor ordered, Ullman argued. Specifically, he suggested: (1) a $52 billion cut in Social Security payroll taxes, with rates dropping from 6.65 percent to 4.5 percent for both workers and employers; (2) a $50 billion cut in personal income taxes, with credits for the poor and elderly and various investment incentives; and (3) $28 billion cut in corporate income taxes, with the top rate dropping from 46 percent to 36 percent, as well as "substantial depreciation reform."

Consider the following tax reform: (1).Impose a retail sales tax on consumer goods and services, both domestic and imported. (2) Use some of the proceeds from the tax to repeal the corporate income tax. (3) Use the rest of the proceeds from the tax to significantly cut the payroll tax.

Was Ullman ahead of his time? I learned about this when I asked someone who knows this history about a 1994 proposal from certain Republicans to have a subtraction VAT much like the Japanese VAT. The Europeans have a tax-credit VAT. GAO explains the details. As I noted earlier, Alan Auerbach has admitted his proposal to end U.S. corporate profits taxes and have us rely entirely on VAT will increase transfer pricing manipulation not lower it:

A lot of folks thought DBCFT would end tax arbitrage but not if the U.S. adopts it alone. It just seems all the work for clever accountants and lawyers will be occurring offshore. Auerbach et al. do make a point that if all nations abandon the taxation of profits and raise retail sales taxes to offset the revenue loss, then transfer pricing becomes irrelevant.

Of course VAT differs in its detailed implementation from a retail sales tax. If all nations went on the European system, Auerbach’s dream of ending transfer pricing manipulation might have a chance. But if the U.S. follows Japan with a subtraction VAT, transfer pricing still matters.

First, the federal government would impose a gradually increasing tax on carbon dioxide emissions. It might begin at $40 per ton and increase steadily. This tax would send a powerful signal to businesses and consumers to reduce their carbon footprints. Second, the proceeds would be returned to the American people on an equal basis via quarterly dividend checks. With a carbon tax of $40 per ton, a family of four would receive about $2,000 in the first year. As the tax rate rose over time to further reduce emissions, so would the dividend payments … According to a recent Treasury Department study the bottom 70 percent of Americans would come out ahead under a carbon dividends plan. Some 223 million Americans stand to benefit.

To examine the effects of a sample carbon tax, OTA estimated the 10-year revenue effects of a carbon tax that started at $49 per metric ton of carbon dioxide equivalent (mt CO2-e) in 2019 and increased to $70 in 2028. We estimate that such a tax would generate net revenues of $194 billion in the first year of the tax and $2,221 billion over the 10-year window from 2019 through 2028. This revenue could finance significant reductions in other taxes. In 2019, this carbon tax revenue would represent approximately 50 percent of projected corporate income tax payments or 20 percent of the OASDI portion of the payroll tax. If the revenue were rebated to individuals it would amount to $583 per person in the U.S.

The authors are looking at a large carbon tax than FHM are proposing, which is why their estimate of the effect of a per person rebate is larger than $500. Table 4 on page 20 provides an estimate the percentage increase in the pricing of various forms of energy. Most interesting is table 6 on page 26 entitled “The Distribution of $49/mt Carbon Tax and Revenue Recycling as it explores the distributional effects of several options including “no revenue recycling”. While FHM advocate complete revenue recycling, some might advocate using the extra revenue to increase certain forms of government spending such as green technology, infrastructure, and even transfer payments such as medical care and Social Security. The reductions in after-tax income from this progressive agenda would tend to hit those with higher incomes more. The authors also estimate the effects of a revenue neutral carbon tax where either payroll taxes or corporate profits taxes are reduced. If the latter is what the politicians end up doing, it follows that the well to do benefit on net while the rest of us pay more.

Sunday, February 12, 2017

Dismissing a half century of successful free market policies is perhaps the worst thing Donald Trump has done to the Republican party. The President’s ignorant beliefs in zero-sum trade policy and massive infrastructure spending repudiates decades of conservative ideology and undermines the American economy. Luckily, while the rest of the Trump administration is marching head on in a radically anti-free market direction, at least one segment hasn’t fallen in line yet. The reliably conservative Vice President Mike Pence has hired one of the libertarian Cato Institute’s top directors as his Chief Economist. Mark Calabria was the Director of Financial Regulation at the Cato Institute until being tapped by the Vice President for this role.

The link is to what clearly is a very rightwing group. Calabria used to work for Senator Richard Shelby and Phil Gramm. He received his degree from George Mason. So what does Calabria think of Dodd-Frank?? Repeal Dodd-Frank? So what’s his reasoning?

After the bank bailouts of 2008, the public was promised “never again.” Unfortunately the same congressional architects of that bailout, Sen. Chris Dodd and Rep. Barney Frank, enacted legislation giving regulators the permanent option of bailouts, as eshrined in the Dodd-Frank Act.

For instance most economists recognize today that many of the New Deal policies implemented in the 1930s slowed the recovery and added to unemployment. Although harder to quantify, an important reason to avoid financial crises is to avoid the policy mistakes that sometimes follow in their aftermath. Accordingly I hope we all share the goal of minimizing both the severity and frequency of financial crises. This is not something we ever want to repeat again ... Key ingredients of this crisis were: exceptionally loose monetary policy ... There is perhaps no issue that drove the passage of the Dodd-Frank Act more than the public perception that certain large institutions enjoyed the backing of the federal government. A situation commonly called “too big to fail” (TBTF). Not by coincidence the first two titles of Dodd-Frank are aimed at addressing the too-big-to-fail status of our largest financial institutions. Here I raise a number of concerns and observations that merit meeting the claim of ending TBTF with considerable skepticism. One reason that debates over TBTF are often so heated is that there is no actual explicit subsidy provided on-budget for such purpose … Section 204, for instance, is quite clear that the Federal Deposit Insurance Corporation (FDIC) can purchase any debt obligation at par (or even above) of a failing institution. If rescuing a creditor at par is not the very definition of TBTF, I’m not sure what is.

Read the entire discussion for yourself as I will concede that I have quoted some of his most right wing comments. But let’s be clear that Dodd-Frank is about a lot more than what to do if a bank declares bankruptcy. I want to return to his most recent discussion as it relates to the issue what we should do to lessen the chances of financial institutions failing in the first place:

It is time for Congress to deliver on the “no bailout” promise. And Rep. Jeb Hensarling has a plan to do just that in his Financial Choice Act. Core to the Choice Act is a move to improve financial stability by increasing bank capital, while reducing reliance on the same regulators who missed the last crisis. While I would have chosen a different level of capital, the Choice Act gets at the fundamental flaw in our financial system: Government guarantees push banks to reduce capital that, unfortunately, leads to excessive leverage and widespread insolvencies whenever asset values (such as houses) decline. Massive leverage still characterizes our banking system, despite the “reforms” in Dodd-Frank. Even ardent supporters of Dodd-Frank, such as economist Larry Summers, have recently concluded it has not made banks safer.

I agree that higher capital requirements would be an improvement but the Goldman Sachs crowd surrounding President Trump are clamoring for lower capital requirements. Maybe Pence and his new chief economist can bring some sanity to this debate. But Dodd-Frank is still about a lot more than capital requirements. Oh wait, Calabria has more to say:

No contributor to the housing boom and bust has been as ignored by Congress as much as the Fed, and its reckless monetary policies in the mid-2000s. Years of negative real rates drove a boom in our property markets. Stanford economist John Taylor has written extensively and persuasively on this topic, yet it remained ignored by Congress. Such reforms are too late to unwind the Fed’s current distortionary policies, but they may moderate future booms and busts.

Saturday, February 11, 2017

Raymond Smullyan died on February 6, 2017 at age 97, a brilliant mathematical logician, philosopher, magician, musician, and several other disciplines. I should provide a link or two or three or more, but if you are interested, just google him. There is a really huge amount there. One of his more amusing yet deep books bore the title, "What is the Name of this Book?"

It is many years since I have seen him, but I knew him personally, and he impressed the living daylights out of me, not merely for his intellect, but also his great and deep wit. He always had everyone around him laughing, and in a world that has always been full of horrors, there is a great virtue in that.

He was one of those who recognized that my late old man had proven the seriously clear and useful version of Godel's Incompleteness Theorem (actually two theorems), the version that makes it clear that consistency implies incompleteness, assuming one is dealing with a sufficiently rigorous logical system. Thus he argued they should be called the Godel-Rosser theorems, as they are called by many in Europe. The key to the "Rosser Trick" is the "Rosser Sentence" that "For every proof of this statement there is a shorter proof of its contradiction." Yeah, that really kills it. I mean, What is the Name of this Book anyway?

As a strictly personal and youthful remembrance, I can report that when I was about 8, give or take a year, he pulled a dime out of my ear that I did not know was there. But then, that is the sort of thing magicians do.

Thursday, February 9, 2017

Intel Chief Paul Otellini said Tuesday that the chip maker will spend $7 billion over the next two years to upgrade its U.S. manufacturing facilities. He made the announcement in Washington, D.C., a surprising place for a chip maker to talk about something as nuts-and-bolts as building a new “fab,” or fabrication facility. Over the past eight years, Intel has built six new fabs, and upgraded another. Since 2002 it has invested $50 billion in capital and R&D in the United States. This is the first time an Intel chief executive has rolled out construction plans anywhere east of the Mississippi River. Even so, this is hardly a political, feel-good exercise. Intel needs its fabs–and in some ways, it doesn’t have much choice but to keep marching along to the relentless beat of technology ... For all the dollars involved in the upgraded fabs, there will be few “new” jobs. Instead, Intel executives say the investment will preserve about 7,000 skilled jobs in Oregon, Arizona, and New Mexico, where Intel will begin making the new processors first. Intel generates 75% of its sales outside the United States, but conducts about 75% of its semiconductor manufacturing inside the Unites States, the company said.

It's worth noting that the original announcement for the Arizona plant in 2011 was done during a visit by President Obama to an Intel plant in Oregon. So Intel's desire to add some presidential flavor to factory announcements is nothing new. But it again puts on display of corporate America's evolving and bifurcated relationship with President Trump: consumer brands conspicuously keeping their distance or actively criticizing the President while manufacturing brands openly work with him to give him credit for hiring decisions which likely have little or nothing to do with him. Intel is of course in some sense also a consumer brand. But since its products are almost always packaged within a piece of hardware produced by another brand - Apple, Lenovo, Dell, etc. - its consumer exposure is much less.

Given all the discussion of the Destination Based Cash Flow Tax, let’s note a few other statistics from their reported financials for 2015. Their total sales were over $55 billion with 75% being overseas even as most of its production was in the U.S. Intel’s pretax income was $14.2 billion with 62% of its sourced in the U.S. under the current corporate profits tax. I would imagine that Intel would receive a yuuuge tax break if the Destination Based Cash Flow Tax is enacted.

Wednesday, February 8, 2017

It is becoming clear that the scale of the botch by Donald Trump in Yemen in his first effort at a foreign military action is much greater than .first reported, as reported by Juan Cole. Right from the start we heard that people in the military were complaining about poor vetting of intel and how there was more military resistance than expected, with one American dying and three getting injured. There was the embarrassment of a bunch of civilians getting killed, with the latest estimate of those now as high possibly as 30. On top of this we had the absurdity of the whole thing being decided mostly over a dinner with Steve Bannon and Jared Kushner the main parties to it, although supposedly SecDef Mattis signed off on it, followed by the bizarre business of Trump not even going to the Situation Room for this his first military outing. Maybe he thought that since there were so many pictures of Obama there, and even with Hillary, that this is not something he wanted to do.

Of course there was pushback from the Trumpisti over this, claiming that the whole thing had been planned by Obama, who had just not quite had enough time (or maybe even guts) to finally sign off on it, and furthermore that some bad leaders of the target group, Al Qaeda in the Arabian Peninsula (AQAP), were killed. The latter may be true, although as Juan Cole reports, the main target of the raid, AQAP leader Qassim al-Rimini, was not killed and has since put out an audio publicly mocking Trump.

But now Cole further reports (as have others) that Obama had apparently not decided to do the raid. It was long planned, but it was not just a matter of waiting for more intel. They thought it was not a wise effort, and indeed it has not turned out well.

On top of that, now the Yemeni government led by Mansour Hadi that the US and Saudi Arabia support has just forbidden the US from engaging in any further ground military assaults. Oh. Cole suggests that aside from the matter of civilian casualties, there is the matter of Trump's insulting Muslim immigration ban, which Cole reports has the leaders of this US-backed Yemeni government "disgusted." Oh.

Before just signing off on this as an unsurprising botch by our horrendous new president, I thought it might be worth looking more closely at the Yemen situation and also the policies of Obama and earlier presidents in connection with it. This ties to what I consider to be the worst thing that Obama did during his presidency, the drone wars. Data on this is not all that available, but thebureauinvestigates has some estimates for whatever the are worth. In 2016 Yemen was second after Afghanistan for being on the receiving end of such drone strikes. There were far more in Afghanistan at 1071 to 38 in Yemen, 16 in Somalia, and only 3 in Pakistan, although back in 2009 Pakistan was the top recipient, with 2010 the top year for such strikes overall. When it comes to estimated civilian casualties, Afghanistan was up to 65-100 for 2016 and Somalia had 3-5, but there were estimated to be zero in both Yemen and Pakistan, although over the whole period since 2009 there may have been up to 100 in Yemen total.

So there we have Obama's seriously morally questionable drone war policy causing an estimated zero civilian dead during 2016, but within two weeks of becoming president, Trump manages to have as many as up to 30 civilians killed in an operation reportedly more generally botched. No wonder the Yemeni government we are supposedly supporting does not want us around on the ground at all.

Let me add just a bit of historical background and discussion of the current situation in this troubled nation. The Yemenis claim to be the "true Arabs," and Ptolemy called the place "Arabia Felix," meaning "Arabia the Happy." Home to the ancient Sabaean Kingdom that presumably produced the Queen of Sheba, it was and still is the wettest and most fertile part of the Arabian peninsula, which made it well off in the ancient world, along with being a major producer and exporter of spices. Now it has the lowest real per capita income in the Arab world, under $4000 per year and even behind pretty pathetic Sudan and Mauretania.

There are two important things that seem to have held true about Yemen over time as it slid from the best off Arab nation to the worst off economically. One is that it has long been very divided with local groups controlling their own territories, even as the place was supposedly ruled by a long string of outsiders up through the Ottomans in the early 20th century. The other has been that those outsiders wanted to control it because of its location at the southern end of the Red Sea, making it a crucial location for controlling trade between the Indian Ocean and the Mediterranean. While the Ottomans officially ruled it from the 1500s onward (it had a brief period of independent and unified rule in the 1300s), they never controlled its highlands, and the British from 1850 on controlled the crucial seaport of Aden near the southern tip. The split between a northwestern part controlled (sort of) by the Ottomans and a southeastern part controlled by the British is pretty much where we are at now with the official capital of Sana'a in the north controlled by rebel Zaydi Shia Houthis, and Aden and the southeast mostly controlled by the official government of Mansour Hadi, backed by the US and Saudi Arabia, with Iran semi-supporting the Sana'a based regime.

The northern highlands have long been the home of the Zaydi (Zaidi) Shia, who converted in the 800s. This is the most moderate branch of Shi'ism, the closest of them to Sunnism, 8-Imam Shi'ism in contrast to Iranian 12-Iman Shi'ism. No outsiders have been able to control them, although many have tried, including the Saudis early in the 20th century, who managed to carve off part of their territory, Asir province, home of most of the 19 Saudis who participated in the 9/11 attack on the US.

After the British pulled out in the early 1970s, their former Aden protectorate became a Marxist regime. The area was traditionally Sunni of the Shafi orientation. However, the two Yemens unified in 1990 under the leadership of Ali Abdullah Saleh, who had led the northern Sana'a-based nation since 1978. He was tossed out in 2012 with the support of the US as a result of Arab Spring uprisings the previous year. But then the Houthi tribe of Zaydi Shia revolted and took control of Sana'a, with the official government of Hadi retreating to Aden. Then the Saudis and the Iranians got involved, with the Saudis doing lots of destructive bombing with support from the US. Juan Cole claims that the claims of Iranian support for the Houthis by the Saudis and US are exaggerated, although one of Sean Spicer's more flagrantly false remarks was to turn a Houthi attack on a Saudi ship into an Iranian attack on a US naval vessel, sheesh. Oh, and to top this off, Saleh is back apparently helping out the Houthi regime in Sana'a, if not quite in charge.

Then, of course, on top of all that mess we have al Qaeda, with it long argued and agreed that the Yemeni branch of it was and has been the most powerful one outside of the Afghan-Pakistani home base, and maybe more so now than there. In late 2000, while Bill Clinton was still president, they successfully attacked the USS Cole. In January, 2001, the Yemen government of Saleh launched a campaign against them. In 2009 they officially joined with the weaker Saudi branch to become AQAP as they continue to be. They long ago managed to gain control of territory in the eastern part of Yemen, which they supposedly still control. Both the Saleh and Hadi governments accepted US intervention there in the form of the drone strikes, even as later the Hadi government would get bogged down in its fight with the Houthi rebellion, which was far from where AQAP operates.

So, big surprise, this is a horrendously complicated and tragic situation, one that obviously took a lot of attention from Obama while he was president, who apparently had managed to get the civilian deaths in the drone war against AQAP down to zero even as civilian deaths in the Houthi-Hadi war have grown, with the US involved through the Saudis on the Hadi side. But now Trump has really botched it, so much so that the Hadi regime says we are not to mess there, and this is an outfit that has planned direct attacks on the US. For all of what Trump claims he wants to do, this really is a massively serious botch, far bigger than was initially reported. Will he and his team learn anything from this? I do not know, but this one will not be easily fixed anytime soon.

Barkley Rosser

Day later addendum: Juan Cole has now posted more from the Bureau of Investigative Journalism, who sent people into the attacked village of Yakla five days after the attack. The number of dead civilians appears to be 25, including 9 children under the age of 13 and 8 women, one of them heavily pregnant.

Tuesday, February 7, 2017

Brad Setser is doing serious thinking about the transfer pricing aspects of the Destination Based Cash Flow Tax (DBCFT). I will read it but first he has distracted me with a link to an interesting paper by Auerbach et al. which includes this important admission:

Taxing business income in the place of destination also has the considerable advantage that the DBCFT is also robust against avoidance through inter-company transactions. Common means of tax avoidance – including the use of intercompany debt, locating intangible property in low-tax jurisdictions and mispricing inter-company transactions - would not be successful in reducing tax liabilities under a DBCFT. Here however the distinction between universal and unilateral adoption is important. With adoption by only a subset of countries, those not adopting are likely to find their profit shifting problems to be intensified: companies operating in high tax countries, for instance, which may seek to artificially over-price their imports, will face no countervailing tax when sourcing them by exporting from related companies in DBCFT countries.

Fourth, the combination of a sharply lower rate, new opportunities for tax arbitrage and the fact that any revenue gains from bringing overseas cash home are one-shot means the Federal revenue base would erode. The result would be cuts in entitlement payments to consumers who spend heavily, tax hikes on individuals and reductions in government spending. Over time, this will slow growth and burden the middle class.

A lot of folks thought DBCFT would end tax arbitrage but not if the U.S. adopts it alone. It just seems all the work for clever accountants and lawyers will be occurring offshore. Auerbach et al. do make a point that if all nations abandon the taxation of profits and raise retail sales taxes to offset the revenue loss, then transfer pricing becomes irrelevant. But let’s be a bit careful as some sales taxes such as the Medical Device Excise Tax is not retail based but set at the manufacturer’s price – an issue we dealt with here. The Auerbach et al. claim is actually well known. But will all nations choose to shift the tax burden from profits to consumption? I’m not sure but maybe the proponents of a worldwide abandonment of profits taxes replaced by higher sales taxes need a slogan:

Monday, February 6, 2017

Pearlstein takes a look at Team Trump’s stance on pharmaceutical pricing. Dean Baker takes issue with this statement:

Because ours is the only country that does not negotiate prices with drug companies, using a national formulary, Americans pay roughly twice what patients in other countries do for the most widely used drugs still under patent. What that means, in effect, is that Americans pay for the 20 percent of drug industry revenue that is invested in researching new drugs, giving the rest of the world a free ride. In exchange for this largesse, a disproportionate share of the high-paying research jobs are located in the United States. Drug companies also used to pay a disproportionate share of corporate taxes to the U.S. Treasury until they became as innovative in tax avoidance as they are in product development.

Dean counters:

Pearlstein is asserting that the United States is making its citizens pay more than people elsewhere for their drugs, in effect as a bribe, to get drug companies to locate research jobs in the United States. This is a clear violation of WTO rules and would be quite a news story if Pearlstein has any evidence to back up this assertion. As a practical matter, we would expect drug companies to locate their research facilities where the cost of the research is lowest. The cost of research is not affected one iota by what a country's citizens pay for drugs. Most likely the reason most research is located in the United States is the enormous subsidies that the government provides through the National Institutes of Health (NIH). It is not a coincidence that a huge number of biotech companies are located in the Maryland suburbs of Washington, right next to the NIH campus.

While this may be true for basic research as phase I and phase II clinical trials, phase III clinical trials need to be conducted in the region or nation where the ultimate drug will be marketed and sold. Let’s take Gilead Science’s latest treatments for hepatitis C virus infection – Havroni and Solvadi – as an example. Gilead sold over $19 billion of these products in 2015 at very high profit margins. U.S. sales of these products were $12.5 billion in 2015. The initial research through phase II trials were not done by Gilead but rather by Pharmasset, Inc. So how Gilead acquire these rights?

Gilead Sciences to Acquire Pharmasset, Inc. for $11 Billion ... Pharmasset currently has three clinical-stage product candidates for the treatment of chronic hepatitis C virus (HCV) advancing in trials in various populations. ... Under the terms of the merger agreement, a wholly-owned subsidiary of Gilead will promptly commence a tender offer to acquire all of the outstanding shares of Pharmasset's common stock at a price of $137 per share in cash.

I suspect this subsidiary was Gilead Ireland Research UC. So this Irish affiliate (think Double Irish Dutch Sandwich) paid for the phase II rights. We can only guess who funded the phase III trials. But it seems a lot of the profits are sourced offshore. We can only speculate what Gilead thinks about the Destination Based Cash Flow Tax. As to the claim that we do not negotiate on prices, this passage from Gilead’s 10-K filing is interesting:

In July 2014, we received a letter from the U.S. Senate Committee on Finance (Senate Committee) requesting information and supporting documentation from us related to Sovaldi and the pricing of Sovaldi in the United States. The letter raised concerns about our approach to pricing Sovaldi, its affordability and its impact on federal government spending and public health. In December 2015, the Senate Committee released the results of the investigation, which alleged that we engaged in a revenue-driven pricing strategy in setting Sovaldi's price. Gilead disagrees with many of the conclusions in the report. In January 2016, we received a letter from the Massachusetts Attorney General that their office is considering whether our pricing of Sovaldi and Harvoni may constitute an unfair trade practice in violation of Massachusetts law. In February 2016, the Massachusetts Attorney General’s office served us with a Civil Investigative Demand requesting that we produce documents related to our HCV products.

Sunday, February 5, 2017

This Destination-Based Cash Flow Tax debate has generated a lot of discussion – some of it helpful and some of it quite confused. Tim Fernholz is making a noble attempt but he stumbles on something others seem to get confused about:

Some of that money appears to be a result of companies shifting earnings overseas by moving their intellectual property (IP) abroad. And some firms whose income is entirely predicated on easily movable IP, like drug makers, have simply moved their headquarters to tax havens in order to escape US tax obligations entirely.

Permit me to interrupt. Inversions only get rid of the repatriation tax. The real issue here is the tendency for companies like Amgen to migrate their U.S. created intangible assets offshore. But this is not where I fear Tim has gone astray:

The next feature of the plan to think about is the destination-based aspect of it. Republicans propose to end the longstanding, uniquely American idea of taxing worldwide income.

Sorry but I need to interrupt again. Other nations are on territorial systems (no repatriation tax) but tax corporate profits on a sourced-based system. Please continue Tim:

If you consider for a minute about what kind of incentives this might create, one of the obvious ideas for an American firm would be to move production and intellectual property overseas, to a low-tax or low-labor cost country, while continuing to sell products in the US. Just as companies today try to shift income overseas because it is effectively untaxed there, they would similarly do so if their foreign income was untaxed by law. To battle this incentive, we finally reach the border adjustment part of the proposal. The adjustment would, at its simplest, make it so that foreign purchases by companies would not be deductible, to balance the lack of taxes on exports—that is, the tax only targets domestic consumption.

Yes Amgen, Apple, and Google source a lot of income abroad under the current system which should receive a section 482 challenge from the IRS. This House proposal would not increase their U.S. taxes at all – it would simply mean that the IRS would no longer be able to challenge such aggressive transfer pricing. So why call this “to battle this incentive”? It is like throwing up the white flag of surrender. This is the point I was trying to make earlier.